Willingness to Pay (WTP)A buyer’s willingness to pay for a good is the maximum amount the buyer will pay for that good.

WTP measures how much the buyer values the good.

1

name WTP

Flea $300

Anthony 250

Chad 175

John 125

Example: 4 buyers’ WTP for an iPod

1. Demand

WTP and the Demand Curve

Q: If price of iPod is $200, who will buy an iPod, and what is quantity demanded?

2

A: Flea & Anthony will buy an iPod, Chad & John will not.

Hence, Qd = __ when P = $200.

name WTP

Flea $300

Anthony 250

Chad 175

John 125

WTP and the Demand Curve

Derive the demand schedule:

3

4John, Chad, Anthony, Flea

0 – 125

3Chad, Anthony, Flea

126 – 175

2Anthony, Flea176 – 250

1Flea251 – 300

0nobody$301 & up

Qdwho buysP (price of iPod)

name WTP

Flea $300

Anthony 250

Chad 175

John 125

$0

$50

$100

$150

$200

$250

$300

$350

0 1 2 3 4

WTP and the Demand Curve

P Qd

$301 & up 0

251 – 300 1

176 – 250 2

126 – 175 3

0 – 125 4

P

Q

Qd=0

Qd=1

Qd=2

Qd=3

Qd=4

$175

$125

4

$0

$50

$100

$150

$200

$250

$300

$350

0 1 2 3 4

About the Staircase Shape…

This D curve looks like a staircase with 4 steps.

5

P

Q

If there were a huge # of buyers, as in a competitive market,

there would be a huge # of very tiny steps,

and it would look more like a smooth curve.

Cost and the Supply Curve• Cost is the value of everything a seller must give up to

produce a good (i.e., opportunity cost).

• Includes cost of all resources used to produce good, including value of the seller’s time.

• Example: Costs of 3 sellers in the lawn-cutting business.

6

name cost

Angelo $10

Hunter 20

Kitty 35

A seller will only produce and sell the good if the price exceeds his/her cost.

Hence, cost is a measure of

willingness to sell.

2. Supply

Cost and the Supply Curve

7

335 & up

220 – 34

110 – 19

0$0 – 9

QsPDerive the supply schedule from the cost data:

name cost

Angelo $10

Hunter 20

Kitty 35

Cost and the Supply Curve

$0

$10

$20

$30

$40

0 1 2 3

P

Q

P Qs

$0 – 9 0

10 – 19 1

20 – 34 2

35 & up 3

$35

8

(1) Consumer Surplus (CS)Consumer surplus is the amount a buyer is willing to pay minus the buyer actually pays.

9

name WTP

Flea $300

Anthony 250

Chad 175

John 125

Suppose P = $260.

Flea’s CS = $300 – 260 = $__.

The others get no CS because they do not buy an iPod at this price.

Total CS = $___.

3. Welfare measures—CS and PS

$0

$50

$100

$150

$200

$250

$300

$350

0 1 2 3 4

CS and the Demand Curve

10

P

Q

Flea’s WTP P = $260

Flea’s CS =

$300 – 260 = $40

Total CS = $40

$0

$50

$100

$150

$200

$250

$300

$350

0 1 2 3 4

CS and the Demand Curve

11

P

Q

Flea’s WTP

Anthony’s WTP

Instead, suppose P = $220

Flea’s CS =

$300 – 220 = $80

Anthony’s CS =

$250 – 220 = $30

Total CS = $110

$0

$50

$100

$150

$200

$250

$300

$350

0 1 2 3 4

CS and the Demand Curve

12

P

Q

The lesson:

Total CS equals the area below

the demand curve & above the price.

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

CS with Lots of Buyers & a Smooth D Curve

Q: P = $30, CS=?

A: CS is the area below the D curve and above the P. Recall: area of a triangle equals ½ x base x heightSo, CS=½ x 15 x $30 = _____

13

The Demand for Shoes

D

h

$

Price per pair

1000s of pairs of shoes

$0

$10

$20

$30

$40

0 1 2 3

(2) Producer Surplus

P

Q

Producer surplus (PS): the amount a seller is paid for a good minus the seller’s cost.

14

$0

$10

$20

$30

$40

0 1 2 3

Producer Surplus and the S Curve

P

Q

Suppose P = $25

Angelo’s PS = $15

Hunter’s PS = $5

Total PS = $20

Kitty’s

cost

Hunter’s cost

Angelo’s cost

Total PS equals the area below the price and

above the supply curve.

$25

15

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

PS with Lots of Sellers & a Smooth S Curve

The supply of shoes

SQ: P=$40, PS=?A: PS is the area below the P and above the S curve.

The height of this triangle is $40 – 15 = $25.

So,PS= _____________ = $312.5

h

Price per pair

1000s of pairs of shoes

$15

16

profit

17

Q

Costs and Revenue

MC

ATCP = $10 MR

50

$6

profit per unit

= P – ATC= $10 – $6 = $4

Total profit = (P – ATC) x Q = $4 x 50= $200

Total profit = TR-TC = ________________

= _________________= _____

Greg Mankiw: CHAPTER 14 FIRMS IN COMPETITIVE MARKETS

4. Profit